U.S. investors brace for mounting political risks as they decode Trump

FILE PHOTO -- A screen shows the Dow Jones Industrial Average over the 20,000 mark following the closing bell on the floor of the New York Stock Exchange (NYSE) in New York, U.S., January 25, 2017. REUTERS/Brendan McDermid/File Photo

NEW YORK (Reuters) - Barry James built up his $4 billion mutual fund largely by studying balance sheets, earnings and market share. In the last few weeks, however, he has realized that he must look at a new force in the market: U.S. President Donald Trump.

Trump’s unpredictable governing style and stated desire to renegotiate trade agreements and punish companies that seek out lower-cost forms of labor are upending the classic notion of fundamental investing, said James, who manages the James Balanced Golden Rainbow fund.

As a result, he said, his Xenia, Ohio firm is broadening the market research it follows. He is also moving more of his money into bonds and bracing for a significant decline in the U.S. stock market, just a few months after making a big bet on equities the day after the Nov. 8 presidential election.

“We’re vulnerable to shocks,” he said, “and we’ve got a shocker in the White House.”

With U.S. equities breaking record highs, other investors who have long shunned big-picture trends say they also are paying more attention to the effect of politics on asset prices, and that the high market valuation sets the scene for a steep sell-off.

Fund managers are not just focusing on whatever company Trump mentions in his latest tweet. They say they are also worrying that he could increase global tensions and raise trade tariffs worldwide, hurting companies large and small.

So far, Trump's political proposals have largely helped the U.S. stock market. Markets are pricing in lower corporate taxes and an infrastructure spending bill, pushing the benchmark S&P 500 .SPX up about 9 percent since Election Day.

The market trades at a trailing price-to-earnings ratio of 20.9, the high end of its historical range.

Yet fund managers say they see markets as increasingly vulnerable to political risks as the new administration targets trade and immigration policies that could shift the balance of the global economy.

At the same time, key elections scheduled for later this year in France and Germany could lead to further weakening of the European Union, a risk that fund managers say the global markets do not fully reflect.

“We’re seeing fatigue in the market in reacting to political situations that would historically be very disruptive,” said BMO Global Asset Management portfolio manager Lowell Yura.

ONE SNEEZE

Some fund managers are now calling in outside political risk experts whom they might have once ignored or expanding their networks of consultants to determine the effects of Trump’s policies on the U.S. market and abroad.

Political risk firms are reporting a significant increase in business since Election Day. Consultant Business Environment Risk Intelligence said investor inquires were up more than 50 percent since November, and it has been telling clients not to be complacent despite the market rally.

“It takes one sneeze from the Trump administration that can spread flu to these markets,” said Chief Executive Officer Saruhan Hatipoglu.

Ian Bremmer, president of New York-based political risk research firm Eurasia Group, said his business had increased significantly since Trump’s election as well as Britain’s vote to leave the European Union, emerging market scandals and the French presidential campaign. This has led him to increase hiring at his 150-person firm.

“Clients are asking about all of the moving pieces,” he said. “It’s suddenly: ‘Are we going to be in a much more protectionist world? Is the global marketplace going to fragment?'”

TRADING TRUMP

Fund managers say they are trying to take advantage of an anticipated spike in volatility, even as the VIX, Wall Street’s main measure of equity market turbulence, remains near two-year lows.

“Donald Trump clearly is showing that he wants to be a disrupter of the status quo, so political risk is probably the single biggest known driver of potential future volatility that exists now,” said Conventus Capital partner Nicholas Young.

Young said his firm had bought options to hedge against market declines for that reason as well as “the unknown drivers that catch people completely by surprise and cause volatility to spike quickly.”

Thyra Zerhusen, co-chief investment officer of Fairpointe Capital in Chicago, said she had been trimming positions in some stocks and was holding more cash than usual as she expects market declines.

Among her worries is that a move to deregulate the banking industry could lead to something like the financial crisis of 2008 and 2009.

“I am trying to batten down the hatches,” she said. “I‘m more concerned about politics now than I’ve ever been.”

Reporting by David Randall and Jennifer Ablan; Editing by Megan Davies and Lisa Von Ahn